Peerflix has a simple business model: Charge users a nominal fee to trade DVDs or CDs, pocket a buck per trade, and build volume. So how much should it cost to pull such a site into profitability? Maybe two million bucks? Not for Peerflix.
[CEO] Mr. McNair said the company in late 2004 raised about $2 million from the venture firms 3I and BV Capital.... That cash would have been more than enough to last until mid-2006, Mr. McNair said, but Peerflix raised another $8 million in October 2005.... More money is on the way.
Now how could this company spend more than $10 million in three years? Is this site that far from running on its own revenue? Of course not — the math below shows why Peerflix should already turn a profit, making it a bad idea to take VC money.
Boring arithmetic begins
Run the numbers: The Times says Peerflix makes two bucks (one per user) per trade, and users are making 5 trades a month. Peerflix boasts 250,000 members. Using the industry rule of thumb for free-registration sites — 1 active user for every 10 registered accounts — that means 25,000 users are making a total of 125,000 trades a month. Even if Peerflix is padding their numbers (they are), they should be pulling in at least a respectable $200k a month — $300k if you count the part spent on shipping costs.
Boring arithmetic ends
$3.6 million a year is fantastic for a little startup with $2 million invested. But for a company that took $10 million, it's nothing special. The CEO shouldn't be bragging — he just gave away more control of his company for no good reason. If Peerflix expands (into CD and book trading, for example) after getting this money, the venture capitalists own a hefty chunk of the new business.
Why did Peerflix take the money? Maybe they plan to expand but don't have the guts to bootstrap; maybe they got greedy; maybe the smooth-talking VCs tricked them into it. But now Peerflix is just another in a long line of startups diluted by wasteful VC money, ruining a perfectly profitable idea.